Friday, January 2, 2009 8 comments ++[ CLICK TO COMMENT ]++

2008 Portfolio Performance

It didn't feel like it to me, perhaps because the Ambac situation kept me out of the market, but I can't believe I just went through one of the biggest crashes in history. I always wondered what it would be to go through a crash, for stock market corrections are what separates the skilled from the rest, and, well, I can say safely, or unsafely, that I have gone through one. Unfortunately my performance has been a disaster and let's take at how 2008 unfolded. (Warning: very long post)

I only started investing seriously since 2004 and this year has been an absolute disaster of epic proportions. I'm really dissapointed with the performance, not because of the monetary losses, but because I feel that contrarians should outperform and post positive (or almost-positive) absolute returns in such markets. Yet here I am, a self-professed contrarian, with poor stock selection. To make matters worse, I had been mildly bearish for a few years and yet couldn't avoid the carnage.

Do note that I do not count cash in my performance. Right now cash is not very large and my goal is to be fully invested nearly at all times (fully invested may include short-term bonds or inverse/short ETFs.) My portfolio is small and I have my entire net worth invested as shown (this could be the dumbest thing ever but we shall see.) But if cash becomes a large portion of my portfolio, then I will start including that. I also measure in my local currency (C$) but have most of my assets in US$ (this is on purpose.)...I benchmark against the Dow Jones Wilshire Global Total Return index since I consider myself to be a global investor. However, comparing against benchmarks may not be fair because I may hold short positions, bonds or commodities, whereas these indexes measure long-only stock positions...

If you see mistakes with my calculations or some source number, let me know.


I. Overall Performance

The graphic below depicts my yearly performance (click for larger image):



As is obvious to any market follower, practically all assets got clobbered. The Dow Jones Wilshire Global TR index did worse than the S&P 500, after performing abnormally well for the last 4+ years. The S&P TSX Composite, the Toronto exchange, was a rocket-ship over the last 4+ years due to its heavy commodities and financials weight. But it crash-landed back to earth this year and did far worse than the S&P 500. I suspect the commodity indexes (Canada, Brazil, Australia, Russia, e.t.c.) will underperform the S&P 500 for the next 2 or 3 years at least.

The overall return seems respectable, even though it is deeply negative, but it is far worse than the situation of most value investors and some contrarians. Even though some of these value investors are posting a greater loss, I would consider their portfolio to be superior to mine in the grand scheme of things. There are two reasons for this.

First of all, a huge chunk of the returns, a full 17.79% of it, comes from the big decline in the Canadian dollar (my currency) against the US dollar. Without this benefit, I would post a return of around -30%, which is nowhere near being good. (Admittedly, I have been bullish on US$--still am--so some of it is due to positioning.)

Secondly--this is very important--many of my core holdings have seen massive real losses (you know, those real credit impairments that Martin Whitman always refers to.) Unfortunately, the loss in BCE, a failed risk arbitrage, is a real loss; Takefuji, a japanese subprime lender, also has deteriorated although the full extent is not clear; and finally, Ambac has clearly recorded sizeable impairment--at least at the price I bought it at (if you bought at a lower price, it's too close to call.) In contrast, there are a lot of investors, including some prominent value investors, who are reporting huge declines in share prices but I believe those may be quotational loss (i.e. irrational market pricing that has nothing to do with fundamentals or intrinsic value.) It is unlikely for my portfolio positions to recover whereas those with quotational losses will see huge increases in the future.

Similar to last year, risk arbitrage saved the day again. This is by design--I talked early in the year about how Warren Buffett posted positive returns in the bear markets in the 70's mainly due to arbitrage/workouts--but it doesn't provide comfort in my stockpicking skills. Ignoring special situations, I only purchased one stock last year, Ambac, and it has been an absolute disaster. The fact that my macro views have unfolded in an interesting manner also confuses matters for me because I was moving away from macro due to my lack of confidence in my calls (I'll post about this in the future.)

II. Detailed Performance

Shown below is my individual security performance:



Ambac
I only made one purchase this year...and it was a big one. My only investment this year, ignoring risk arbitrage, was Ambac. It was a big concentrated bet and it was a total disaster. It was a weird situation for me given how things unfolded. It is beyond surreal when one invests in something and it collapses by 70% within 3 days. Of course, this is after watching the stock collapse 50% or 60% already over the perior year. Yes, that's what happened to Ambac :) I was not sure if I made a mistake initially because the credit markets were a mess and seemed irrational, but after management severely diluted shareholders it crystallized the losses. It's still not clear how bad the situation really is. There is a very tiny possbility of breaking even simply because the shares were purchased way below book value (something like 50% of book value if I remember) but I'm not betting on that. If the situation improves and I'm confident with expected losses then I might actually average down but that's not high on my list.

One positive thing about the Ambac fiasco is that it made me very cautious about the whole market and the world economy. This is one of the reasons I never invested in anything even though things looked really attractive in the summer. If the market was correct in its view of the monoline bond insurers such as Ambac, the world was facing a serious problem. I remember someone investing in one of the monolines with the justification that if MBIA or Ambac collapsed then the whole market and the economy was going to collapse. The implication of course was that the investment was worth it because if the investment failed then the rest of their portfolio and life was going to be messed up too. Well, they were, unfortunately, right and hence made a dumb investment. The markets did collapse and the monolines also collapsed. They probably lost more money on the rest of their portfolio than on the monolines but it was still a bad move.

In any case, the investment was terrible but it kept me from further danger--although I would have preferred to not suffer at all.

Bell Canada Enterprises
Nothing much to say here. I was waiting for my first risk arbitrage failure and it ended up being BCE. The BCE takeover took a very long time with many setbacks and controversies along the way (it's a good case study for risk arbitrage investors.) I'm dissapointed with the outcome but I'm satisfied with my investment process. The important thing to realize about risk arbitrage is that it is a statistical bet. Small investors, such as myself, don't want to have a single failure but the fact of the matter is that it is unlikely. As Warren Buffett has pointed out, as long as you keep making similar bets with high probabilities, you will be fine. For example, if you keep investing in deals with, say, 70% success rate, you will get 3 fails for every 10. But depending on the size of the losses relative to the gains, that's fine. If you are a small investor taking his or her first 3 risk arbitrage positions, failing one might be painful but the key is the long-run. Just keep learning, keep your average high and greed low :)

I'm ok with owning BCE because it is a type of company that can hold its ground when the economy is weak. This doesn't mean that its stock price won't drop if management makes mistakes but I'm confident with ownership in BCE. The only downside with BCE is that many American risk arbitrageurs lost huge sums because, depending on when you bought it, you may have lost an additional 15% on the currency alone.

Guest-Tek Interactive
No point talking about this. Legacy position that is less than 0.1% of my portfolio. Should have sold out a long time ago. I do not recommend any reader to pay attention to this.

Horizons S&P TSX 60 2x inverse
This, long-timer readers may recall, was my bearish macro bet on commodities. I decided to short the TSX last year (via a 2x inverse ETF) because it is a commodity-oriented index which had something like 50% in energy and materials. It's important for you to realize that the inverse funds provide the negative of the daily return. It is possible for the inverse fund to be nowhere near the negative of a long fund during volatile periods (check this SeekingAlpha post by Trader Mark to see how weird the results can be.)

I said at the end of last year that this was a mistake and I'm never shorting anything ever again. The concern was not my macro view (I was even more bearish on commodities at the end of year, especially when Potash corporation became one of the largest companies in Canada--for a period in early 2008, it was actually #1 in terms of market cap); rather my concern was that markets can stay irrational longer than I anticipated.

Well, in the end, this actually helped my portfolio. Some readers may recall how I remarked several times that my portfolio is almost like a market-neutral fund since this double inverse ETF went up quite a bit whenever the market declined. I didn't make a lot of money on this (total return over two years of around 8% per year) because commodities ran up a lot and I sold out before the huge plunge.

Although commodities collapsed and I made a little bit of money, I'm still not clear if my macro view is correct. Some commodity bulls argue that what we have seen is simply irrational selling due to de-leveraging or panic. So I will only know in an year or two if commodities were indeed overvalued. If commodities do not recover to prior prices within that time period, I know my macro call was correct.

I'm still not sure if I'm cut out for shorting. When oil hit $147, I thought I was in big trouble and was starting to get really concerned about this. I have to think about this experience before I pursue any shorting ideas (the only one that piques my interest right now is shorting gold.)

Jaclyn
This was an odd-lot tender offer that closed successfully. These are the ideal situations for small investors but I'm not sure how to find these. The amount of money that can be made is very small (generally you can only buy up to 99 shares so if the share of a hypothetical company is $10 and the spread is 20%, you are looking at 20% of $990 or $200.)

Montpelier Re
Core holding that held up in this nasty bear market. The stock had a huge plunge a few months ago but seems to have recovered and is, amazingly, up a few percent for the year (in US$ terms.) In Canadian dollar terms, it's up 22%. I was thinking of averaging down when the price collapsed but was too scared given how it was already a big chunk of my portfolio.

Puget Energy
Risk arbitrage deal that seems to have received government approval on December 30th. The deal should close early January. I suspect you won't see many wide arbitrage spreads from now on. Unfortunately for risk arbitrageurs like me, I suspect we will also see less cash deals (stock deals require arbitrageurs to hedge by shorting and I'm not quite skilled to do that yet.)

Takefuji
I haven't followed it closely in the latter part of the year. When I get bored, I'll check out what has happened to this company over the year. The stock is down significantly, even though the Japanese Yen appreciated a lot and there is also a 6% dividend (at my purchase price.) But the whole Japanese market has sold off, including companies I believe whose fundamentals have not deteriorated. So I don't know how much of the Takefuji loss is real. The situation has gotten worse for Takefuji but I don't know if it warrants a 70% loss in share price.


III. Historical Observations

Given the monumental time we are facing, I thought I would take a look at my long-term history and see how my performance has fared.



The list above shows my life-time investments sorted from gains at the top to losses at the bottom (in Canadian dollar amounts.) New readers can get a sense of my evolution. I used to be more of a speculator before, taking positions in beaten-down stocks like Atari, Avon, or Biomet without doing much valuation analysis. The bull market saved me but this is a dumb strategy. Most of the profits in the past, before I started the blog, comes from commodities. I was a commodity bull before (influenced by Marc Faber and Jim Rogers, among others.) Then I became bearish on commodities, way, way, too early, and became more of a long-term contrarian investor, influenced more by sources such as Warren Buffett (but I still do not consider myself a value investor and I don't think Buffett, Graham, Scholes, Whitman, et al, would either.) This latter stage has also produced my biggest losses, nearly all of them coming from financial companies tied in various ways to lending or real estate.

I also became a far more concentrated investor about one or two years ago. I think concentrated investing is the ideal technique but only a few are cut out for it. Based on my horrible performance this year, the verdict is still out on concentrated investing. I may dumb the concentrated strategy if I still feel uncomfortable.

The second graphic below shows all my historical returns sorted from highest percentage returns to lowest:



The numbers here may be inconsistent with prior-reported numbers (say from last year or earlier) because I use Microsoft Money to track my portfolio (I also use a spreadsheet as backup and for tax purposes) and it computes returns based on current exchange rates. In contrast, numbers reported in the past use exchange rates at that time. This generally wouldn't matter much to most people but I have holdings in multiple currencies (US$, C$, and Yen) and will probably increase the currency exposure in the future (especially if I turn bearish on US$.)

The positive return rate (i.e. investments with returns greater than 0%) is 69%.

Positive returns excluding risk arbitrage/special situations is 68%.

Percent that beat the market (where market return is assumed to be 10% per year) is 42%.

It's surprising to me that the risk arbitrage return success is similar to the total. I would have thought that risk arbitrage success rate would be higher. This could be because of the very low sample size (I have only handled 4 cases that would fall under risk arbitrage or special situations.)

I have to try to increase the percentage that return 10% or more (my definition of market in this analysis.) My goal is to try to raise that past 50%.


IV. Future Goals

Similar to my goal from last year, I need to improve my tax efficiency. I will actually pay capital gains and dividend taxes this year even though my total returns are deeply negative. The reason, of course, is that I didn't sell the losers while some of the risk arbitrage positions were sold at a profit. My income is low; my portfolio is small; and my tax bracket is kind of low too; so taxes aren't a big deal yet. Nevertheless, I need to improve efficiency.

My second goal is to increase the percent that beat my market return definition of 10%. Truthfully, this isn't a big goal for concentrated investors. Avoiding a few blow-ups is far more important than trying to raise the success rate. But it's still something nice to tackle.

I need to figure out whether I should be in the shorting game or not. I just don't feel comfortable after doing in once with that TSX inverse ETF. Shorting has become popular now that we are in a bear market but that's not the reason for me to think about this issue. I think a lot of people pursuing shorting now or trying to hedge via shorts are going to pay a big price. My reason for thinking about shorting is not for those reasons. Rather, I'm interested in shorting because it fits a contrarian perspective. Contrarians often have bearish perspective long before others and irrespective of market conditions. Shorting fits that thinking. For instance, I'm nervous about gold because it has run up for 5+ years. It might actually be the best performing investment in the last 10 years! (another potential short is long-term US government bonds but I'm still leaning towards deflation so wouldn't consider a short any time soon--this is especially dangerous if the FedRes starts buying US bonds as it has suggested.)


Thanks for reading what may be longest post of all time... my life is kind of messed up--not really but still single and bored to death--so I suspect I may never write anything this long on such a lame topic as my portofolio performance ever again, assuming my life gets better :)

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8 Response to 2008 Portfolio Performance

contrariandutch
January 2, 2009 at 6:16 AM

Happy new year Sivaram!

May your life be less boring (and single?) in 2009 and your investment results beat the markets always.

In the mean time, don't be to harsh on yourself. You just made it trough a truly historical market crash with only a modest loss. And yes, the currency effect counts for the return. It is as much a picked position as any stock pick. (then again, I would say that as my own return this year is rather currency dependent)

January 2, 2009 at 9:26 AM

Happy new year.. Look forward to reading more of your macro perspective.

January 2, 2009 at 2:52 PM

It might be you got lucky on the C$ but don't be so hard on yourself. Even Buffett was down 32% and lots of decent investors were down 40-50% in 2008.

2008 was truely humbling but good investors need to learn humility - get too arrogant and the market inevitably slaps you in the face.

January 2, 2009 at 3:11 PM

Good Job Siv. Quick Comment,,
"I just went through one of the biggest crashes in history"

You went through THE biggest crash in history for one year

ray
January 2, 2009 at 8:31 PM

Sivaram,
You should be truly proud of all the knowledge that you dispensed for all of us.
Even though I trade options but my thinking is very much like yours.
I want to follow the macro trends but this market has been harsh.
I love your insight and having my most favorite investment web site.
Have a great and happy new year.

January 3, 2009 at 1:29 AM

Thanks for the kind words guys & gals... I hope all the best to you in this new year...

January 3, 2009 at 6:25 AM

Thanks for sharing the information. Past is a lesson where we have to learn a lot from it. Hope the year 2009 would bring out of the greedy year 2008. I believe 2009 would bring cheers to stock market investors.

January 9, 2009 at 1:45 PM

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